The Solo 401k deadline to establish a plan for 2020 rapidly approaches. This is the time of the year to think about how to lower your taxes. Convert what would be paid in taxes into money funding your retirement savings! Opening a Solo 401k is like having four aces in a high stakes game. It’s very common for taxpayers to maximize the tax-deferred funding of an IRA at this time of the year. But savvy money managers go for the maximum income tax deferral (up to $63,500 contribution limit) that is only available with a Solo 401k account.
Here is what you need to know to get started….
SECURE Act and Solo 401k Deadline for 2020
The Setting Every Community Up for Retirement Enhancement Act (SECURE ACT) became law in December 2019. Inside the law is a clause extending the date to open a Solo 401k through tax day plus filed extensions.
IMPORTANT: IRS and the SECURE Act: The act extended the deadline to open a Solo 401k. The amended deadline is the extension date for filing your tax return. However, the IRS has not yet updated its guidelines (IRS Publication 560, p. 3, table 1). Current guidelines still state the account must be opened by 12/31/20. Until the IRS updates their guidelines, the safest approach is to open the account before the end of the year. You can then fund the account going into 2021 plus any extensions.
From IRS Publication 560, Chapter 5: “Set-up deadline. To take a deduction for contributions for a tax year, your plan must be set up (adopted) by the last day of that year (December 31 for calendar-year employers).”
Make a Plan for 2020 Taxes
Fortunately, people who are aggressive about minimizing taxes and maximizing retirement funding don’t tend to be procrastinators. The Solo 401k plan by Nabers Group is the most flexible and compliant plan available. You can set up your Solo 401k account today and contribute on your own schedule with no minimum contributions (contribution FAQs).
Setting up your Solo 401k and making contributions are two separate actions. You have until the due date of the tax return for your business to make contributions. If you file an extension for your tax return, you can contribute up to the extension date. Contribution deadlines are also explained in IRS Publication 560 (the Solo 401k is a “qualified plan” under IRS rules).
Opening your Solo 401k now enables you to begin funding it when you choose and gradually reach the contribution limit over many months (but before the deadline). A lump-sum contribution is not required. Just as important, by opening the account now, you can rollover your existing retirement funds to take full control of your investments immediately.
Contribute up to $63,500 per year
You can make a maximum $63,500 contribution to a Solo 401k (depending on age and compensation). For those under the age of 50, the maximum contribution is $57,000 for 2020. How much you will actually be allowed to contribute (and tax-defer) can be 100% of your self-employed compensation plus the business-matching portion.
Once you open a Solo 401k, the maximum amount goes up almost every year based on inflation. It’s the most aggressive tax-deferral retirement program available for small businesses. Typically, the owner is the only employee or the owner and spouse (it also works with a business partner).
Even if you are just starting your business, setting up your retirement plan is an important part of the business. Use the Solo 401k Contribution Comparison Calculator to estimate potential contributions to a Solo 401k plan compared to a Profit Sharing, SIMPLE, or SEP plan. Proper tax planning requires an awareness of what’s new and what changes from year to year.
Understanding the Solo 401k
A Solo 401k is a special type of retirement account designed for self-employed workers with no employees other than a spouse. A Solo 401k works similarly to a 401k that you may have through an employer, except you have complete control over your retirement investments. You can have both a Solo 401k and a traditional 401k through another employer.
With a Solo 401k, the business owner wears two hats: employee and employer. Contributions are made to the plan in both capacities. You can contribute like any traditionally employed worker up to 100% of your compensation. This contribution maxes out at $19,500 or $26,000 if you are age 50 or older. But as your own employer, you decide how much additional funds the business will contribute to your retirement.
A business owner who is also employed by a second company and participating in that company’s 401k plan should bear in mind that his limits on elective deferrals are by person, not by plan. He must consider the limit for all elective deferrals he makes as an employee of both companies during a year. However, the amount one company contributes to your retirement does NOT affect how much the other company can contribute. For this reason, many Solo 401k owners contribute the maximum allowed from their self-employed business.
Putting on your employer hat, the calculation is a little more complicated. You may contribute up to 25% of your net self-employment business income for the year. That is all the money you’ve earned from your business minus any business expenses, half of your self-employment taxes, and the money you contributed to your Solo 401k as an employee contribution.
Although terms like “100% of employee compensation” and “all of the money you have earned with your business” are very enticing, the reality is there are ultimate limits. Only the first $285,000 in net self-employment business income counts for the year. Also, the total amount that can be contributed between the employee and employer portions in 2020 is $57,000 or $63,500 if you’re 50 or older. (In 2021, this total increases to $58,000 or $64,500 if you’re 50 or older, and the net self-employment business income maximum increases to $290,000.)
Investment Flexibility before the Solo Deadline for 2020
You have complete control over your retirement account and what you choose to invest in. Additionally, there is tremendous flexibility with a Solo 401k. For instance, you also have the option of making after-tax contributions using a Solo Roth 401k. You can even have multiple accounts that include both a tax-deferred Solo 401k and an after-tax Solo Roth 401k. You can also take a loan from your Solo 401k just as you can from a traditional 401k. Historically, you’ve been limited to the lesser of 50% of your balance or $50,000. However, congress doubled these limits in 2020 to help those affected by the pandemic.